Florida Property Insurance

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1 Florida Property Insurance The Window of Opportunity Bulletin Originally published by Towers Perrin Introduction There is no question: Florida s insurance market is in a state of disarray, and property insurers and homeowners have huge challenges ahead of them. Uncertainties about the quality, price and availability of property insurance have left homeowners desperately seeking stability, and insurers are struggling to meet demands. But, faced with regulatory changes, crippling natural disasters and the uncertain impact of future catastrophic events, they have minimal fl exibility. Ultimately, both insurance providers and consumers want more certainty about the future of property insurance in Florida, along with a better, more effi cient insurance market. In this context, Towers Watson has examined several proposed or enacted state policy decisions. These policies are designed to reshape Florida s insurance market and strike a balance among the general price, availability and quality of property insurance. Each policy decision will have varying degrees of effectiveness in addressing these issues. Background Florida lawmakers have sought to enact policies that stabilize the price, availability and underlying quality of property insurance. For example, the recently passed bill, HB 1495, will reduce the amount of reinsurance offered by the state-run Florida Hurricane Catastrophe Fund (FHCF) by $12 billion over the next six years while instituting a cash build-up program to pay claims. The legislature also voted to incrementally raise the rates that state-run Citizens Property Insurance Corporation charges for its property insurance policies. These changes are designed to strengthen these state agencies and shift more of the region s hurricane risk to well-capitalized private insurance and reinsurance companies. The changes have distinct benefi ts for Florida s lawmakers and its residents: A higher proportion of future hurricane losses will be paid from private capital rather than being passed on to the taxpayer in the form of assessments. Florida s insurance market still presents structural dilemmas. Strong private insurance markets are characterized by the orderly matching of buyers and sellers, adequate coverage for virtually all consumers, competitive prices and moderate government intervention. In general, Florida faces challenges with each of these elements and, as a result, its government plays a more active role in structuring the insurance market. Ultimately, both insurance providers and consumers want more certainty about the future of property insurance in Florida, along with a better, more efficient insurance market. The degree to which a state government regulates its insurance market is a conscious choice. Industry stakeholders citizens, lawmakers, companies and others decide how best to share risks among themselves. Understanding the private/public participation is particularly important given the variety of House and Senate bills that have been introduced to address insurance prices and availability. A number of options exist for the sharing of risk between private entities and the public. Exhibit 1 shows the continuum of options for risk sharing, ranging from a fully state-run catastrophe pool that assumes all of Florida s hurricane risk, to a market in which private companies Exhibit 01 State-run wind-only pool [A] Current system Partial competition [B] Unregulated free competition Florida Property Insurance Bulletin January

2 assume it all. Presumably, a loss that occurs under the state-run wind-only pool would be fully paid by Florida s policyholders and taxpayers, whereas losses under the full-company assumption would be paid by private company capital. An analysis of positions A and B follows, both of which were subjects of recent Florida legislation. State-Run Wind-Only Pool While a few of Florida s recent policy changes will incrementally decrease the public sector s role in the market, other proposed legislation is more ambiguous. For example, House Bill 1157 and Senate Bill 2384 propose the creation of a state-run wind-only pool for Florida s hurricane insurance risk. Under this system, property owners would have two policies one with a state-run pool for hurricane coverage and another for the balance of their homeowners coverages. Proponents of these bills assert that a wind-only pool would stabilize the insurance marketplace by pooling funds locally and eliminating the profit load that private insurers and reinsurers include in hurricane premiums. This sounds logical on the surface. However, digging a little bit deeper reveals some interesting considerations. Towers Watson recently conducted a study that examines the fi nancial implications of HB A few of the study conclusions are particularly compelling. For example, the creation of a wind-only pool would dramatically increase Florida s reliance on funding catastrophes after they occur. Specifi cally, Towers Watson estimated that any event above a one-in-30- year storm would increase the state s reliance on post-event funding. A one-in-100-year storm, for example, would increase the state s unfunded hurricane liabilities by $14.8 billion, or 59%. More importantly, the unfunded liability would be even greater if Florida were to experience another storm season similar to 2004, when four major hurricanes struck the state. The increase in unfunded liabilities is a direct result of removing private insurance and reinsurance capital from the Florida market. Exhibit 2 shows the amount of unfunded liabilities under the current system and the proposed state-run pool. The creation of a wind-only pool would dramatically increase Florida s reliance on funding catastrophes after they occur. The fi nancial crisis has prompted vigorous debate concerning the viability of a post-event funding strategy that relies on Florida s ability to sell bonds to fi nance unfunded hurricane liabilities. These bonds are to be repaid by a surcharge on private insurer premium rates a questionable arrangement given capital market tightness in the wake of the financial crisis. In fact, the state s three investment bank advisors estimate that Florida has between $4.5 billion and $10 billion in bonding capacity for Florida selected $8 billion as its projected estimate, which falls well short of Florida s one-in-100-year bonding requirement of close to $40 billion. Exhibit 02 $100 Amount (in billions) Difference represents increase in post-event funding amount under pool $ Return Period (one in X year) Total insured loss (claims and adjusting costs) Pre-event funding Current Pre-event funding Pool Source: Towers Watson estimate Florida Property Insurance Bulletin January

3 Exhibit 3 provides an interesting comparison of Florida s potential unfunded hurricane liabilities and its ability to raise debt financing to pay for them. To date, the largest state debt issuance has been California s 2002 $12.3 billion bond. Florida s potential hurricane liabilities are more than three times that amount, making its ability to fund catastrophes after they occur highly questionable. We can assume that HB 1495, which reduces the amount of coverage provided by the FHCF, was passed with this issue in mind. Clearly, the creation of a state-run wind-only pool directly confl icts with the goal of shifting more of the state s hurricane risk to private insurance and reinsurance companies. In fact, the pool would dramatically increase the state s reliance on post-event funding and increase the amount of future assessments levied on Florida s residential and commercial insurance policyholders. Exhibit 03 Amount (in billions) $ $70 1-in-100 post-event funding Current system in-100 post-event funding Pool Florida 2009/10 budget 2 Largest municipal/state bond issuance (California 2002) FHCF estimated bonding capacity Towers Watson calculations 2 Source: Source: html 4 Source: Ash Williams, executive director of the State Board of Administration, Statement to the Florida Cabinet, April 14, 2009 Partial Competition Two more controversial bills, HB 1171 and SB 2036, were introduced in the last legislative session in an attempt to move the state in the other direction, closer to a market-based solution. They were designed to give a small number of large insurance companies the freedom to charge rates that are not subject to approval by the state s Office of Insurance Regulation (OIR). In the House version of this bill, companies would have to meet one of the following criteria: $500 million or more in surplus funds (surplus is the amount that existing assets exceed projected liabilities) $200 million in surplus funds and a net written premium-to-policyholders surplus ratio of less than two to one Greater than $150 million in surplus and selling primarily to nonprofi t organizations Companies that do not meet these criteria must continue to fi le rates with the OIR. Proponents of HB 1171 assert that consumer choice is expanded by allowing Florida s residents to choose between large companies that charge their own actuarially calculated rates and smaller companies that are subject to the state s rate regulations. HB 1171 was widely supported by legislators; 75% of senators and 89% of representatives voted in favor of the bill. Also, the Florida Chamber of Commerce, which includes industry heavyweights such as The Walt Disney Company and Publix Supermarkets, supported the bills. These actions would shift the riskiest policies to Florida s smaller insurance companies and Citizens. Ultimately, rate regulation will become more tenuous as small insurers, having the least amount of rate flexibility, seek larger and larger rate increases to compensate for the increased risk of their portfolios. Florida Property Insurance Bulletin January

4 Despite overwhelming support for the bill, Governor Charlie Crist vetoed it, possibly because of the potential effects of the proposed change. Opponents of the bill note that it would create an untenable situation for the majority of Florida s insurance companies. Specifi cally, opponents assert that large insurance companies will price themselves out of the state s riskiest regions and attempt to compete more aggressively on less risk-exposed business. These actions would shift the riskiest policies to Florida s smaller insurance companies and Citizens. Ultimately, rate regulation will become more tenuous as small insurers, having the least amount of rate fl exibility, seek larger and larger rate increases to compensate for the increased risk of their portfolios. On the surface, this pair of bills appears to move Florida closer to a competitive market. However, this shift comes at a cost, creating additional market distortions by having two sets of rules for competing companies. Further, the follow-on effects would almost certainly result in a greater concentration of high-risk policies with state-run Citizens or smaller insurers. As a result, while a competitive market would be created for a select few companies, the larger and riskier balance of the market would likely become increasingly dysfunctional, and reliance on state-run providers would increase. Revisiting Certainty Florida has become one of the most complex insurance markets in the world. The policy changes detailed above show the challenges that market participants face in developing effective and sustainable insurance solutions. Examining these policies makes certainty seem like an elusive goal and it is. Insurers exist to understand and address this uncertainty by alleviating the stresses associated with catastrophic loss. Whether an insurer can achieve this goal depends on its ability to price policies at levels that are commensurate with the true underlying cost of risk. The exact price point is not a perfect science, but private-market insurers and reinsurers have advanced tremendously in their ability to measure and predict risk. Reinsurers and insurers statistical sophistication will continue to strengthen as time goes on. Private insurers are embracing better risk measurement tools such as predictive modeling to evaluate risk at a policy level. Simultaneously, insurers are using economic capital modeling to manage the amount of capital that is at risk for the aggregate insurance portfolio. Ultimately, the two-pronged policy-level and aggregate approach allows the insurer to charge the true cost of risk and ensure that capital is available when disaster strikes. This evolving approach is changing insurance markets globally and providing more efficient risk transfer from policyholders to insurance companies. Conclusion Florida s stakeholders are actively working to create a stable and well-functioning insurance market. Towers Watson notes that insurers are moving closer to achieving this goal through more sophisticated risk management practices and improving regulatory relationships. Clearly, two factors are contributing to more stable and stronger insurance markets globally: Risk-based pricing at an individual policy level Insurance regulation that constructively addresses capital adequacy Florida has become one of the most complex insurance markets in the world. A review of recent proposed and enacted legislation puts these principles at odds and shows confl icting objectives. HB 1157 was designed to concentrate the state s hurricane risk into one state-run pool. This contradicts HB 1495 s goal of shifting risk away from Florida s residents to private-market insurers. The controversial HB 1171 attempted to move Florida closer to a market-based solution. It would have provided certain large insurers with rate fl exibility, but created an uneven playing fi eld. Florida s recent efforts to reduce FHCF coverage, increase FHCF rates and strengthen Citizens rates offer positive incremental changes to the Florida marketplace. While only incremental, these changes move the state closer to risk-based pricing, which is a key feature of a strong and sustainable insurance market. The relatively benign 2009 hurricane season will enlarge the window of opportunity to move Florida s insurance market closer to a position of strength. Florida Property Insurance Bulletin January

5 Contact James Hole Stephen Lowe Anthony Shapella Paul LeStourgeon About Towers Watson Towers Watson is a leading global professional services company that helps organizations improve performance through effective people, risk and fi nancial management. With 14,000 associates around the world, we offer solutions in the areas of employee benefi ts, talent management, rewards, and risk and capital management. Originally published by Towers Perrin. Copyright All rights reserved.

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